Monday, 2 June 2014

The Kwacha can be rescued

Editor's note : Dr Mbita Chitala provides some reflections on the challenges facing the Kwacha and how it can be rescued. In particular, he argues that Zambia should impose capital controls, move away from a floating exchange rate system, and get rid of the current economic managers in order to restore confidence :

Many Zambians are disturbed that the Kwacha has continued to depreciate raising the spectre of compromising our economic performance and further increasing the poverty and inequality of our people. The free fall of our Kwacha has been on account of three reasons.

First, the PF government exchange rate policy inherited from the MMD government of using market-determined (termed floating) exchange rates where the value of the Kwacha is determined by market forces; Secondly, the unfettered international private capital flows such as the Euro Bond and other foreign bank borrowing, Portfolio Investment, Foreign Direct Investment and other Transnational Corporations activities, and ; thirdly, the lack of confidence in our economy managers occasioned by the costly introduction of SI 33 and the suspension of SI 33 and SI 55 without altering the content of our economic management.

The introduction and later suspension of SI 33 and SI 55, has resulted in large capital outflows (termed capital flight) which has been putting pressure on the Kwacha and resulting in its depreciation. As all students of economic theory know, the decrease in the demand of our Kwacha is central to why it is depreciating. This has been occurring because the Mining Companies together with all other investors including our own nationals have been selling their assets or relocating them offshore to secure jurisdictions.

This capital flight has further induced a vicious circle of additional flight and Kwacha depreciation, debt service difficultied and the reduction in stock or other asset values. This is because the panicked investors have been selling their assets en masse to avoid new capital losses brought about by anticipated future depreciation of the Kwacha or asset values.

This capital flight has aggravated Zambia’s macroeconomic vulnerability and financial instability which has culminated in the present exchange rate crisis.

It is important that the government takes up urgent measures and considers changing the current regime of floating exchange rate policies and introduce the pegged exchange rate system in which the value of the Kwacha will be allowed to fluctuate only within a narrow band (pegged exchange rate).

However, introducing a new policy exchange rate regime of pegging the exchange rate will not be sufficient unless our government considers introducing capital controls. Capital controls or the measures to manage the volume, composition or allocation of capital flows and or maintenance of restrictions on investor entrance or exit opportunities.

There is historical evidence all industrialized countries utilised capital controls successfully over long periods. This is true today for China, India, South Africa, Botswana , Brazil as it was for all European countries after WW II, the USA in 1963, Japan and South Korea in 1960s, Malaysia in 1994 and 1998.

In our country, it would be advised that these capital controls could presently target our specific vulnerability, namely, the capital flight and use and identify the specific ‘trip wires’ and ‘speed bumps’ in various domains such as the Kwacha collapse, flight of capital and then take steps to curtail these risks by activating a target capital control- the speed bump. It is in this vain that windfall taxation of our natural resources such as our base metals and emeralds should be seen.

Capital controls are beneficial to Zambia because in our small and underdeveloped economy, First, the controls will promote our financial stability and prevent our social and economic devastation; secondly, capital controls will promote desirable types of investment and financing arrangements; and thirdly. capital controls will enhance our democracy and national independence.

Lastly, It is important that that the bad image that our economic managers at the Ministry of Finance and the Bank of Zambia are responsible for, namely, of having introduced SI 33 in particular which prevented investors and owners of assets from using them freely in Zambia, is urgently addressed.

It is apparent to all and sundry that it will only be a foolish investor who will bring his assets to Zambia if the management is still in the hands of those who caused so much damage to investors and the country in the first instance.

(Author : MBITA CHITALA PhD)

QUESTION:

Do you agree that Zambia should impose capital controls and abandon the current floating exchange rate system?

Do you agree with Dr Chitala that investor confidence will not return as long as the current economic managers are not fired?

2 comments:

On the second question I would agree that confidence cannot be restored until the current managers are removed. The assumption in this answer is that they cannot change.

The first question is more difficult to answer. My view is that all currencies should be floating. To move from floating to fixed with a band indicates substantial structural problems in an economy. It may appear necessary in a crisis to shore up a currency but all it does is give the currency a false value. The effect of this is the creation of a parallel market in goods and the currency. Official rates against unofficial. In other words, economic death. Note he is recommending capital controls on exit of investments. This means no investment really. If you move to the effect of this on wages then you can see the whole problem. The real value of wages will collapse. So it is no solution at all. What is clear then is that with the answer to 1 then there would be no need for capital controls and fixed rates. So his idea falls.

Even Finance Minister Chikwanda has stated that Zambia's FOREX market is 'controlled by a cartel', and that prices are basically fixed. Don't count out the possibility that the fall of the Kwacha is a bear raid by hedgefunds. This is what happens when the value of the national currency is allowed to be determined by international markets, when the concentration of money is this extreme. You are going to get collusion, and political attacks on 'unpopular' governments.

Announcing the revocation of statutory instruments number 33 and 55 this morning to address the free-falling kwacha, said Zambia's foreign exchange market was an imperfect market ?controlled by a cartel that was influencing the recent kwacha depreciation against major convertibles.

....

And Chikwanda said lack of significant participation of Zambians in the economy had resulted in foreign exchange market being controlled by a cartel of foreign companies.

?"These exchange rates are not determined by market forces, to some extent, there are market forces but very imperfect market forces because the exchange rates in Zambia are determined by the banking system through their interbank lending arrangements," he said.

"So, it's determined by a cartel; by an oligopoly because there is no meaningful Zambian participation apart from small banks like Investrust and so on. These banks are foreign players, so, the sensitivity towards public interest is not as high as it is if there was more meaningful Zambian participation. The long-term cure is for enhanced Zambian participation. The so-called market determination of the kwacha exchange rate is an imperfect market."??

....

End Quote

Welcome to the 'tyranny of the markets', which is really the same old bankers who used to own the mines before the end of colonialism.

Finance Minister Alexander Chikwanda signed Statutory Instrument (SI) number 33 of 2012 on May 7, 2012 which came into effect on May 18 2012, prohibiting the quoting and pricing of goods and services in foreign currency.

SI55 would monitor inflows and outflows of international transactions, according to The Post: In July 2013, the government introduced SI 55 which empowered the Bank of Zambia to monitor currency inflows, outflows and international transactions and regulate charges in the financial sector.

So why would this lead to a massive fall in the value of the Kwacha? Is there really 'capital flight', or is this a bear raid coming out of the financial markets? The fall of the Kwacha is very reminiscent of how George Soros (OSISA) made his billion pounds betting against the British Pound.

In other words, is the Zambian government being 'punished' for daring to regulate the economy, or just the currency, by introducing SI 33 and SI 55?

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